Societal CDMO, Inc.
Q4 2022 Earnings Call Transcript

Published: 1 Mar 2023

[Operator:]

Good day, ladies and gentlemen, and welcome to the Societal CDMO Fourth Quarter and Full Year 2022 Financial Results Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will follow at that time. As a reminder, this conference may be recorded. I would now like to hand the conference over to Stephanie Diaz of Societal's Investor Relations Group. Please go ahead.

[Stephanie Diaz:]

Thank you. Hello and thank you for joining us. On today's call, we have David Enloe, President and CEO; and Ryan Lake, Chief Financial Officer. Today, we will be providing an overview of Societal's contract development and manufacturing business, including updates on corporate activities and financial results for the quarter and full year ended December 31, 2022. After our prepared remarks, we will welcome your questions. Before we begin, I'd like to caution that comments made during this conference call today, March 1, 2023, will contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 considering the current beliefs of the company, which involve a number of assumptions, risks and uncertainties. Actual results could differ from these statements, and the company undertakes no obligation to revise or update any statement made today. I encourage you to review all of the company's filings with the Securities and Exchange Commission concerning these and other matters. Our earnings press release and this call will include discussion of certain non-GAAP information. You can find our earnings press release, including relevant non-GAAP reconciliations, on our corporate website at societalcdmo.com. With that, I will turn the call over to David Enloe, Societal's President and CEO. David?

[David Enloe:]

Thank you, Stephanie, and thank you to everyone participating today via webcast. 2022 was an important and transformative year for Societal driven by the company's outstanding performance across each of its five strategic objectives for the year. As stated in early 2022, these five objectives were to employ new marketing segmentation strategies and strengthen the company's corporate identity; optimize our facilities and expand our capabilities; enhance our client experience through reliability, consistent quality and regulatory excellence; support talent retention by creating an inspiring and supportive environment for our employees; and finally, to significantly strengthen our financial position. We are pleased with the advancements that our team accomplished in each of these priority areas during the year, positioning us well to capitalize on the opportunities that lie ahead. We are also very happy to report that we were able to achieve our 2022 financial revenue and EBITDA guidance that was narrowly set and maintained from the outset, particularly given the generally unfavorable market dynamics, rebalancing of inventory from one of our sales and distribution partners, and the inflationary environment in which we currently operate. I will provide a more detailed review of our 2022 achievements following an overview of our financial results for the quarter and full year ended December 31, 2022. So with that, I will turn the call over to Ryan.

[Ryan Lake:]

Thank you, David. Good afternoon, everyone. Before I begin, in addition to the brief financial overview I'll provide on the call today, additional details on our financial results for the fourth quarter and year ended December 31, 2022, are included in our press release issued prior to this call and in our Form 10-K, which is on file with the SEC. I'll begin with an overview of our financial results for the fourth quarter. Revenues for the fourth quarter ended December 31, 2022 were $24.3 million and reflects our highest revenue quarter of the year as well as higher than any quarter in the past two years. This represents a 9% increase compared to revenues of $22.3 million recorded during the prior year period. The increase of $2 million was primarily driven by an increase in European Ritalin LA demand from the company's new customer, InfectoPharm; as well as an increase in revenue from the company's largest commercial customer, Teva, correlated with pull-through in demand resulting from market share gains against the sole competitor for the Verapamil SR products. These increases were partially offset by lower revenues from commercial product sales in San Diego compared to the prior year due to timing of customer shipments. Cost of sales for the quarter ended December 31, 2022, was $17.4 million compared to $15.7 million for the comparable period of 2021. The increase of $1.7 million was primarily due to increased costs associated with the clinical trial materials business as we expand capabilities, increased personnel costs primarily due to certain 2021 employment incentive tax credits that were not repeated in 2022, resulting in increased expense in 2022; and increased costs tied to the higher manufacturing revenue during the quarter. Selling, general and administrative expenses for the fourth quarter of 2022 were $6 million compared to $5.3 million recorded in the 2021 period. The increase of $0.7 million was primarily related to costs associated with the refinancing in the fourth quarter of 2022, offset by lower public company costs and administrative costs than the prior year. Interest expense was $3.7 million for the three months ended December 31, 2022, an increase compared to $3.5 million for the comparable period of 2021. The increase of $0.2 million was primarily due to an increase in the variable LIBOR component of interest on the company's prior term loans. This increase was partially offset by decreases in capitalized interest and the extension of the maturity date of the company's prior term loans, which deferred a portion of the non-cash amortization of financing expenses to future periods, resulting in lower non-cash interest in Q4 2022 compared to Q4 of 2021. For the quarter ended December 31, 2022, the company recorded a net loss of $9.2 million or $0.15 per diluted share as compared to a net loss of $2.4 million, or $0.04 per diluted share, for the comparable period of 2021. Net loss for the quarter ended December 31, 2022 included refinancing costs, loss on extinguishment of debt and tax expense of $7.9 million, or $0.13 per diluted share. EBITDA as adjusted for the period was $5.3 million compared to $3.2 million in the prior year period. I'll now provide an overview of our financial results for the full year 2022. Revenue for the year ended December 31, 2022, was $90.2 million compared to $75.4 million for 2021. The increase of $14.8 million in revenue was primarily driven by an increase in European Ritalin LA demand from the company's new customer, InfectoPharm, as well as an increase in revenue from the company's largest commercial customer, Teva, correlated with pull-through in demand resulting from market share gains against the sole competitor for the Verapamil SR products. In addition, there were higher revenues from the company's clinical trial materials business as well as a full year of revenue resulting from the acquisition of IriSys compared to approximately five months of revenue in 2021. The increase in revenue was partially offset by a decline in revenue from Lannett's commercial sales of the Verapamil PM products. Cost of sales for the year ended December 31, 2022 was $67.1 million compared to $55.6 million in 2021. The cost of sales increase of $11.5 million was primarily due to the acquisition of the San Diego facility and certain 2021 employment incentive tax credits that were not repeated in 2022, resulting in increased expense in 2022. These increases were partially offset by the reallocation of expenses reflecting the post-acquisition organizational structure. Selling, general and administrative expenses for the year ended December 31, 2022 were $21.9 million compared to $18.4 million in 2021. The increase of $3.5 million was primarily related to costs associated with the debt refinancing in the fourth quarter of 2022 and increased personnel costs tied to the reallocation of expenses. Specifically, effective October 1, 2021, certain employees who previously supported the company's plant operations, now support our multi-site organization structure and operations. Accordingly, expenses associated with these employees have been reclassified from cost of sales to selling, general and administrative expenses. These increases were offset by lower IriSys acquisition and integration costs. Interest expense was $14.1 million and $15.1 million for the 12 months of 2022 and 2021, respectively. The decrease of $1 million was primarily due to the extension of the maturity date of the company’s prior term loans, which deferred a portion of the non-cash amortization financing expenses to future periods and increased capitalized interest. These decreases were partially offset by a full period of interest on the debt portion of the IriSys acquisition purchase price and an increase in the variable LIBOR component of interest on our prior term loans with Athyrium. For the year ended December 31, 2022, Societal reported a net loss of $19.9 million or $0.34 per diluted share compared to a net loss of $11.4 million or $0.26 per diluted share for 2021. Net loss for the year ended December 31, 2022 included refinancing costs, loss on extinguishment of debt and tax expense of $7.9 million or $0.14 per diluted share. EBITDA as adjusted for the year ended December 31, 2022 was $16.2 million, compared to $16.6 million in the prior year period. During the 12-month period, lower sales of Verapamil PM by Lannett, negatively impacted EBITDA as adjusted by approximately $2.3 million as compared to the 2021 period. At December 31, 2022, Societal had cash and cash equivalents of $15 million, compared to $25.2 million as of the end of the prior fiscal year. This concludes my financial overview. For those interested in reviewing our non-GAAP reconciliations, please refer to our 8-K filing or the press release issued today. I’ll now turn the call back over to David for an update on operations and achievements during the period. David?

[David Enloe:]

Thanks, Ryan. One year ago, the company outlined an aggressive road map for 2022, including objectives spanning sales and marketing, corporate identity, facilities and capabilities, stakeholder engagement, and finally, our financial position. During the year, we successfully executed on these objectives, creating a stronger and more capable CDMO. I will first address the company’s strategic achievements impacting sales, marketing and corporate identity. During 2022, the company adopted three discrete sales strategies designed to best serve each of the market segments within which we engage

[Operator:]

[Operator Instructions] Our first question comes from Matt Hewitt with Craig-Hallum. Your line is open.

[Matt Hewitt:]

Good afternoon, gentlemen. Thanks for the update and congratulations on the strong finish to the year. I’ve got a handful of questions. Maybe first up, you announced on the call that you are prepared to potentially launch a biologics manufacturing capability. How should we thinking about that opportunity? Like what does the sales cycle look like? How quickly do you think that you could sign a contract in that market? Hello.

[David Enloe:]

Can you hear me okay?

[Matt Hewitt:]

Now I can, yes.

[David Enloe:]

Okay. I’ll start over. Yes, so this is not related to large molecule production, drug substance-wise, but as I stated, to fill/finish and lyo capabilities. And so we view this as an opportunity to increase our target markets. And I would look at it really no differently than anything that we’ve talked about or discussed before, other than the fact that we knew going into the acquisition of IriSys year and a half ago that, that expertise existed historically. We just wanted to make sure everything was up and running, functioning well. And we had seen some success in the new line and the new lyo. So we’re ready to roll that forward. And the business development team members we’ve added also have that expertise. And so it’s time to step that out in a more formal way.

[Matt Hewitt:]

Got it. And then on the 20-80 market opportunity, maybe if you could update us on how that pipeline is coming together, opportunities there?

[David Enloe:]

Yes. I mean a lot of discussions are in that area, and this is going to be a place of focus going forward. And right now, it is still nascent, I would say. It is novel. And I’ll just say that we’ve gotten the attention of a couple large non-U.S.-based entities to examine this as an opportunity for them.

[Matt Hewitt:]

Got it. And then, obviously, a strong performance here in Ritalin and Verapamil. How should we be thinking about those products for fiscal 2023? How is that captured in your guidance?

[Ryan Lake:]

Matt, it’s Ryan. So first, I’d say that, generally speaking, and maybe I’ll back into your question is that from a development revenue perspective, we’re expecting to see an increase of about 35% to 50% in our development revenue over 2022. And that’s really our growth segment of our business. And our commercial business, we’re expecting it to be relatively flat to down slightly. So the overall average of the revenue growth would be in the high single-digit range. And keep in mind that the development revenue is growing at three times to five times the market rate. And because the commercial revenue weighting being about 70% of our total revenue, the overall revenue growth is weighted down a little bit and kind of mutes the growth that we’re seeing in the development revenue. But we’ve got a really good line of sight to our development revenue and expecting to earn approximately 60% of the backlog that we had at the end of 2022. So that was approximately $24 million. And just looking at – and there’s a deck in our slide – slide in our deck that we put out as well that shows what our funnel looks like and what some of those pipeline opportunities are. But based on what we have to signed backlog as well as signing and executing on additional new business and scope changes based on, as David mentioned, a much larger customer base, we feel like we’re in a good shape from a sales funnel perspective to execute on the strategy.

[Matt Hewitt:]

Excellent. Maybe one more and then I’ll hop back in the queue. But on the gross margin side, a nice pop here in Q4. As you look at fiscal 2023 and maybe even beyond, if you’re willing to comment on that. But for fiscal 2023, as you continue to increase your utilization, I mean, is it reasonable to expect your gross margins to continue to expand over the course of the year? I realize that there’s some puts and takes with inflationary pressures and all of that and some new hires. But as you look at fiscal 2023 versus fiscal 2022, gross margin should be up. Is that fair?

[Ryan Lake:]

Yes. So, we’re expecting gross margins to be in the mid-20% range, so 25% to 27% or so. You’re not seeing some of the leverage improvement due to some of the infrastructure growth and cost inflation that we’re experiencing. And I’d say that this business is significantly different than it was just a couple of years ago, as David mentioned in his opening remarks. I mean we’re supporting a lot more of different and not more of the same. And we’ve been running very lean as well from a head count perspective. So there’s kind of a tremendous workload and complexity our teams are managing due to our growth and juggling all the supply chain challenges, the timing of production runs and completing those services.

[Matt Hewitt:]

So maybe a little bit of an uptick here this year, but maybe a more pronounced pickup in gross margin in 2024 and beyond?

[Ryan Lake:]

Yes. I think that’s fair, Matt.

[Matt Hewitt:]

Okay. Thank you very much.

[Operator:]

[Operator Instructions] Our next question comes from Jacob Johnson with Stephens. Your line is open.

[Jacob Johnson:]

Hey good afternoon. David, maybe going back to your comments around the funding backdrop, I guess two questions. One, does your guidance assume kind of a somewhat more challenged, if you want to use that word, environment? And then two, I’d just be curious how this – you talked about how the environment is impacting kind of your business development effort where you’re hunting. How does it impact kind of the – does it impact the customers you want to work with back use of it?

[David Enloe:]

Well, yes, I mean, good question. I – my – and we talked about this several quarters ago before it really started happening, but I mean I at least could see and we could see it coming. For me, it only further emphasizes the importance of the tech transfer gains that we’ve been able to see, these new projects that we’ve been able to add that are either commercial and coming in or near commercial and coming in because those – typically, those programs are, by and large, less capital market-dependent, right? However, the early part of the product development curve where so many of our programs are arriving, I mean, there’s no question that we’re seeing, and other companies are too, obviously, companies who might have three programs that they intend to go into the clinic and they were going to do that concurrently and then "go raise more money" at the end of that when they figured out what they’re doing on the next phase and that there is more care now and more conservatism now as those smaller emerging companies are being more cash-conscious and preserving their cash as long as they can. So, I think – well, first of all, directly to your question, I mean we did factor that into our guidance and into what we’re seeing in terms of our funnel. But it is something that we’ve got to be aware of and be careful with, with respect to making sure that companies were spending time trying to work with are funded or have sight – line of sight to that funding before we expend a bunch of energy on something that’s not going to go anywhere.

[Jacob Johnson:]

Okay. That’s helpful. Thanks for that. And then just on the Verapamil side of things, I think you called out some share gains that benefited growth in 2022. Is that something that – is there a risk for those gains reversing next year? Or do you see that kind of remaining kind of where it is today?

[Ryan Lake:]

Hey, Jacob, it’s Ryan. So I would say that, we continue to see Teva performing at a very high level and maintaining their market share position and even increasing it a little bit. And we actually think they want to increase their business with a new customer that should help contribute to increase profit sharing for us. But we did I would say, experience in the fourth quarter and something we’ve baked into our guide is that there was some softness in kind of the net pricing by our partners. So their gross to nets were a little bit higher. So that’s something we’re keeping our eye on. But the market share position for Verapamil still very strong.

[Jacob Johnson:]

Okay. Thanks for that, Ryan. And then just last question for David, just congrats on getting the balance sheet in a much better place. I guess that begs the question in terms of capital allocation, does that change your view or appetite around anywhere you’d want to invest organically or I suppose inorganically?

[David Enloe:]

I mean, we’re – there’s a lot of activity right now with companies paying very close attention to the assets they have and the assets that they want to have. I’ll say it like that. And so, there’s a lot of activity in that area. We’re not actively trying do something else right now. I mean, this is still a tough market, right? And we’ve got capacity that we need to fill and that’s where our business development efforts are focused, and that’s why we’ve re-engineered the way we’re approaching the market, where we’re really delving more deeply and intensely into the relationships that are already exist for us. And examining and exploring ways that we can deepen those relationships with incremental work and extra projects in addition to the fill/finish line capacity that we have available, and also other tech transfer opportunities. So I would characterize 2023 more that way though there’s no question that opportunities are going to arise and we’ve got to assess those.

[Jacob Johnson:]

Got it. Makes sense. Thanks for taking the questions.

[Operator:]

One moment for our next question. Our next question comes from Max Smock with William Blair. Your line is open.

[Max Smock:]

Hi, thanks for taking our questions. Maybe just following up on one of Jacob’s questions about what’s embedded in a guide here. In terms of your shift to biologics, are you expecting any contribution in 2023? And then from a competitive standpoint, is this – is there anything to read into in terms of this being an indictment of growth in small molecules? Or is it just the function of demand and biologics being so robust? And what do you think you can do in that market to really differentiate you from some of the larger, more established players in the space?

[David Enloe:]

Hey, Max. I mean, on the filling of biologics, I – we’ve had this experience. The people and the team in San Diego have built biologics before. I mean, certainly the crux and focus and vast majority of the work that we’re doing is small molecule focused and centered. However, once we got the line up and running and in fact have already engaged in a fill and lyo opportunity that involves a biologic and a complex one at that. It’s time for us to step that forward and increase the number of opportunities that we can possibly take on. I think from a differentiation perspective, the focus that we have on the client experience is the same. It’s being available and having a scientific sort of best foot forward if you will. And really working to solve problems that our clients have with respect to their programs and be ready and able and to apply the quality system and regulatory expertise and supply chain expertise we have. And we didn’t take stepping into the biologic space from a fill and lyo perspective lightly. I mean, we’ve walked all the way around this in terms of incremental skills we need or knowledge that we need to have to be competent and competitive and we feel like we’re in a good place now to step that forward. Not sure I, there was a first part of the question, Max and I dove into the second part if I didn’t answer…

[Max Smock:]

I lumped too many in there. That was my fault. The first part of the question was just around what exactly you’re expecting or what’s embedded in the guide from biologics here in 2023?

[David Enloe:]

Yes, I mean, I would just say that the expansion of opportunities is baked in to the forecast and the guidance that we’re providing.

[Max Smock:]

Got it. All right, thank you. Maybe a longer term one here on margins, I guess, I’m assuming the wages obviously is the big headwind here in 2023, but is there anything else that you’d call out in terms of what’s behind the step down in margin in 2023. And then beyond 2023, any commentary you can provide around how we should think about the potential for cadence and margin improvements longer term?

[Ryan Lake:]

Yes, Max. So first, I wouldn’t say there’s a step down in margin. It’s relatively in the same range as 2022. And it’s really a factor of more of different, not more of same. So, as we continue to grow in the development business and absorb our overheads, it’s really important for us, as David mentioned, that we’re filling out our capacity. And that’s where we’re really going to see the margin improvement and the leverage of our fixed costs and absorption of our overhead. So it’s a little tough right now, to look out much past 2023, but certainly we expect a pretty significant improvement as we absorbed our fixed development costs and then as some of these tech transfer programs start to come online including two of them this year from a commercial standpoint.

[Max Smock:]

Got it. Okay. And then maybe one last one for me, just in terms of results in the quarter. I think when we spoke last quarter, you had mentioned that you had a potential headwind from the delays in API shipments from Italy for Verapamil. It doesn’t seem like that impacted results in the quarter, but is there any risk of that carrying over here in 2023? And then relatedly maybe on the other side, was there any positive impact from the ADHD shortage that we’ve seen really over the last year or so now?

[Ryan Lake:]

Yes, I don’t recall. I know we talked about API availability, but not necessarily a shortage on the Verapamil side. Certainly, our supply chain folks are monitoring that and doing a good job at making sure that we have the appropriate levels. And I don’t think that we saw, again, anything discernible from an ADHD perspective from the Adderall shortage. I mean, we still continue to see back to normal levels from pre COVID in terms of our ADHD products and our new partner. In fact, pharma is doing really well with Ritalin in Europe. And what’s included in our guide for next year, but for all of our commercial products is basically a customer forecast that we receive, which are 12 month, 24 month forecasts. And those are risk adjusted slightly by us as well. So we feel good about the commercial projections that we’ve provided.

[Max Smock:]

Perfect. Thank you.

[David Enloe:]

Yes. Matt, let me just – this is David. Let me just reiterate. I tip my hat to the supply chain team. We did get out ahead of the API challenge that was – had real potential. We've heard less about power prices in Western Europe than were anticipated when this all came up last quarter, and it was really one of the main topics of the CPHI Conference in Europe last end of October, early November. And we are in better shape and more confident about the API situation with Verapamil than we were at that point.

[Max Smock:]

Got it. Thank you David. Very helpful and thanks Ryan.

[Ryan Lake:]

Absolutely, Max.

[Operator:]

[Operator Instructions] Our next question comes from M. Marin with Zacks. Your line is open.

[M. Marin:]

Thank you. So I have two questions. One is a follow-up to prior questions and discussions we've just had. In terms of what's fully baked into guidance, you had said that you have been running kind of lean in terms of head count. So should we think in terms of supporting the growth that you've outlined, the opportunities you've identified that you believe you have sufficient bandwidth now in terms of head count to fully support these opportunities? Or at some point, do you think we might see some ramp-up in staffing at some point in 2023?

[Ryan Lake:]

Yes. So included in our guide is that anticipated hiring of those individuals to support the revenue. And just generally speaking, they're not even new positions. They're just backfills of positions that we had previously included in there. And that's – the lean part is we've been running kind of down without them. But that is included in our guide, those additional headcount to support the revenue that we have, just more in a sustained manner and also one that is supporting, as I mentioned earlier, more of different and not more of the same given the number of development customers that we have now.

[M. Marin:]

So given the state of the labor market, do you think there's any potential risk that you might have to provide additional incentives or inducement in that regard?

[Ryan Lake:]

I don't think so. Not at this time. Our people and culture team does a tremendous job at making sure that we're benchmarking and staying competitive. And as we've talked about previously, we made some changes during the year as well in terms of talent acquisition, bringing it in-house as well as a number of initiatives from a culture perspective to make Societal a really great place to work at and attract and retain talent.

[M. Marin:]

Okay.

[David Enloe:]

Yes. Marla, I want to reinforce something there. I meet every month our Chief People Officer, and I meet every month with all the new employees and had a chance to do that yesterday. And I just want to say, I mean, excellent new team members that we've been able to add who are very – bring a lot of experience from other places, either from the client side or other CDMOs. And I've really been pleased with the talent that we've been able to attract and secure at the company.

[Ryan Lake:]

I think one other comment, Marla, that maybe I'll help you with, maybe how to think about cadence of revenue and supporting expenses. For the total year, I would say that revenue is going to be weighted about 45% toward the first half of the year and then about 55% towards the second half of the year. And the breakdown in the first half of the year will depend on a number of factors, including timing and completion of – our second step of the serialization compliance is the aggregation step under the Drug Supply Chain Security Act. And that will cause some shifting of production and shipments between quarters, but we expect revenue would be weighted more heavily toward Q2 in the 55% range and about 45% weighted toward Q1. And then we also experienced an extremely high throughput of clinical development services in Q4 of 2022, which included some really large project milestones being met, including the Otsuka process qualification batches. And we are anticipating lower development backlog to be earned in Q1. So that's what's driving some of that quarter-over-quarter. And then I would say, from an EBITDA perspective, that cadence, again, it's based on revenue timing and mix, but it would be weighted about 40% toward the first half and 60% toward the second half. And the breakdown of the first half of the year, again, depending on timing and the aggregation compliance, is expected to be weighted about 75% towards Q2 and about 25% to Q1 given the production, revenue timing and absorption of overhead. So overall, I think the EBITDA margins, which includes the new headcount for the year, will be in the mid- to high teens range. And if you're looking at some of the EBITDA comparisons, one thing to note, and we included it in the back of the press release, is as historic EBITDA as adjusted number, which excludes adjustments for the adoption of the revenue recognition standard. And now that we've kind of have all periods – prior periods that are presented excludes that new standard for comparability purposes, we're going to eliminate that adjustment to reduce and simplify the number of variables for EBITDA estimates from period to period. So we provided those calculations again in the non-GAAP tables. So you can see the impact to the historical periods and how we're guiding for 2023 compared to 2022.

[M. Marin:]

Got it. Thank you.

[Operator:]

And I'm not showing any further questions at this time. I'd like to turn the call back over to David for any closing remarks.

[David Enloe:]

Yes. Just a quick point of clarification before I completely wrap up, and that is I want to make sure that the listeners here that are on the biologics side, the extent of production capabilities that we're offering is limited to formulation, fill and finish and not drug substance production. So I just wanted to clarify that. So on that note, many thanks to all of our clients, our supply chain, our other service providers and partners and our – particularly to our excellent Societal team. We look forward to many great achievements in the months ahead. And thank you again, everybody, for participating today and for your continued support of Societal CDMO.

[Operator:]

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.

[David Enloe:]

Thanks, Kevin.